Introduction

Crypto airdrops have become an increasingly popular way for blockchain projects to reward early adopters, gain new users, and attract media attention. While receiving free tokens or coins is great, it's important to understand the tax implications of crypto airdrops. Failing to report airdrop income can lead to severe consequences, including penalties and potential legal issues.

What is an Airdrop?

An airdrop is a popular marketing strategy used by crypto companies to distribute free tokens or coins to a large number of wallet addresses. The primary goals of airdrops are to reward early adopters, attract new users, and generate momentum and hype for the project.

How are Crypto Airdrops Taxed?

The taxation of crypto airdrops typically involves two components: ordinary income tax on the airdropped assets and capital gains tax when those assets are sold or disposed of.

Ordinary Income Tax on Airdrops: Most tax authorities, including the IRS in the United States and HMRC in the United Kingdom, consider airdropped cryptocurrencies or tokens as ordinary income. This means that you must report the fair market value (FMV) of the airdropped assets on the date you received them as taxable income.

Capital Gains Tax on Airdrop Sales: If you later sell, trade, or otherwise dispose of the airdropped assets, any gain or loss will be subject to capital gains tax. The cost basis for calculating the capital gain is typically the FMV of the airdropped assets on the date you received them.

It's important to note that the specific taxation rules for crypto airdrops can vary significantly depending on your country of residence and the reason for receiving the airdrop.

Crypto Airdrop Taxes in the United States

In the United States, the Internal Revenue Service (IRS) has provided clear guidance on how to treat crypto airdrops for tax purposes. According to the IRS, airdropped cryptocurrencies or tokens are considered ordinary income and must be reported on your tax return for the year in which they were received.

Reporting Airdrop Income: You should report the FMV of the airdropped assets on the date of receipt as "Other Income" on Form 1040, Schedule 1. For example, if you received 100 tokens with an FMV of $5 each on the date of the airdrop, you would report $500 as ordinary income.

Calculating Cost Basis for Capital Gains: When you sell or dispose of the airdropped assets, you will need to calculate your capital gain or loss. Your cost basis for these assets is the FMV you reported as ordinary income when you received the airdrop. Continuing the example above, if you sold those 100 tokens for $1,000, your capital gain would be $500 ($1,000 sale price - $500 cost basis).

Example Scenario: Let's say you received 500 UNI tokens from the Uniswap airdrop on May 1, 2024, when the FMV of UNI was $7 per token. You would report $3,500 (500 x $7) as ordinary income on your 2024 tax return. If you later sold those 500 UNI tokens for $5,000 on June 1, 2024, your capital gain would be $1,500 ($5,000 sale price - $3,500 cost basis).

Crypto Airdrop Taxes in the United Kingdom

The HM Revenue and Customs (HMRC) in the UK has issued specific guidance on the taxation of crypto airdrops. According to HMRC, whether you pay income tax on an airdrop depends on the reason you received it.

Income Tax for Airdrops: If you received an airdrop as a reward for existing trades or for performing a specific action (e.g., sharing a social media post), it is considered income and subject to income tax. However, if you received an airdrop without providing any service or action in return, it is not considered income.

Trader vs. Non-Trader Status: If you are considered a trader (i.e., your primary source of income is from crypto investments), you may be subject to income tax on airdrops even if you did nothing in return.

Reporting Airdrop Income and Capital Gains: You must report airdrop income on your Self Assessment Tax Return. When you sell or dispose of the airdropped assets, any capital gain is also reportable on your Self Assessment Tax Return or through the Capital Gains Tax Service.

Crypto Airdrop Taxes in Australia

The Australian Taxation Office (ATO) has released updated guidance on how it views crypto airdrops. In most instances, such as if you've received airdrops as part of a marketing campaign, the ATO considers your airdrop to be ordinary income, subject to income tax upon receipt.

Income Tax on Airdrops: Most airdrops, excluding initial allocation airdrops, are considered ordinary income in Australia. You will need to report this income on your Individual Tax Return Form, which can be done online through MyTax.

Exception for Initial Allocation Airdrops: The ATO states that initial allocation airdrops, where you've paid nothing to receive the tokens, are not considered ordinary income or capital gain upon receipt. However, disposing of these tokens would later be subject to capital gains tax, with a cost basis of zero.

Reporting Airdrop Income and Capital Gains: Both airdrop income and capital gains from selling airdropped assets are reported on the Individual Tax Return Form, which can be completed online through MyTax.

Crypto Airdrop Taxes in Canada

The Canada Revenue Agency (CRA) does not view airdrops as a type of income, provided you're trading on an individual level and not as a cryptocurrency business. However, when you sell an asset received through an airdrop, it would be subject to capital gains tax.

Capital Gains Tax on Airdrop Sales: Since there is no cost involved in receiving an airdrop, the entire sale proceeds are subject to capital gains tax in Canada. The CRA uses the adjusted cost basis method for calculating capital gains.

Reporting Capital Gains: Capital gains from selling airdropped assets are reported on a Schedule 3 Form, which can be done online.

Crypto Airdrop Taxes in Germany

In Germany, the Federal Central Tax Office (BZSt) does not consider airdrops as income or subject to income tax. Additionally, because there is no purchase transaction involved, airdrops are also not subject to capital gains tax when the assets are later sold.

Tax-Free Treatment of Airdrops: Both receiving airdrops and selling the airdropped assets later on is tax-free in Germany, according to the BZSt's current guidance.

Example Scenario: If you received an airdrop of 500 tokens in Germany, you would not need to report the airdrop as income or pay any taxes on it. If you later sold those 500 tokens for €10,000, you would also not be subject to capital gains tax on the sale proceeds.

Crypto Airdrop Taxes in Other Countries

The tax treatment of crypto airdrops varies significantly across different countries, and many jurisdictions have not yet issued specific guidance on the matter. It's important to check your local tax regulations and seek professional advice from a qualified tax professional or accountant familiar with cryptocurrency taxation in your country.

Challenges and Considerations

Dealing with Data Gaps and Missing Records: One common hurdle in reporting crypto airdrops is missing data sources and historical records. Failing to link all wallets and exchanges can lead to inaccuracies in tax calculations. Even self-transfers, which are not taxable, must be tracked for precise classification.

Spam Airdrops: Not all airdrops are legitimate, and spam or phishing attempts are common. Tax software may struggle to distinguish between genuine and questionable airdrops, potentially resulting in inflated income reports. Manually ignoring such transactions can be cumbersome, especially if dealing with numerous honeypot airdrops.

Legal Ambiguity: Despite some guidance from tax authorities, numerous unanswered questions persist regarding the taxation of crypto airdrops. Certain transactions, like token wrapping, offer multiple tax positions, further add to the complexity in reporting. Unique scenarios, such as crypto losses on a bankrupt exchange, may demand individual analysis.

Complexity of NFT and DeFi Airdrops: Non-fungible token (NFT) and decentralized finance (DeFi) airdrops introduce significant complexity, often overwhelming software's ability to classify them accurately. For instance, one DeFi transaction can generate over a hundred individual entries in the tax software, requiring manual review.

Using Crypto Tax Software

Benefits of Using Crypto Tax Software: Crypto tax software can simplify the process of reporting airdrop income and calculating capital gains. These platforms automate tax calculations based on your location and provide customized tax reports.

How Software Handles Airdrops: Most crypto tax software allows you to tag airdrop transactions and calculates the cost basis and subsequent capital gains automatically. Some also enable you to mark airdrop deposits as income, ensuring accurate income reporting.

Automating Airdrop Income and Capital Gains Calculations: By connecting all your wallets and exchanges to the tax software, you can ensure that airdrop transactions are correctly identified and classified. The software then performs the necessary calculations for income tax and capital gains, simplifying your tax filing process.

Learn more about the best crypto tax software: https://www.archlending.com/blog/7-best-crypto-tax-software-solutions-in-2023

Frequently Asked Questions (FAQs)

Do I have to report an airdrop I didn't want?

Unfortunately, according to current guidance from most tax authorities, you will still need to report the asset as ordinary income based on its fair market value when received, even if you did not actively claim the airdrop.

What if the airdropped asset is now worthless?

You need to realize a loss to report it on your tax return. This can be challenging for assets with no active market. The best solution is to sell the asset for a nominal sum in an arm's length transaction.

What if the airdropped token's value spiked and then plunged?

You must report the fair market value of the airdropped asset on the date you received it, regardless of subsequent price fluctuations. For example, if you claimed an airdrop when the token was trading at $30, you would report that income, even if the token is currently worth much less.

What if I was a victim of an airdrop scam?

Unfortunately, if an airdrop scam caused you to lose funds, there isn't much you can do from a tax perspective. After the Tax Cuts and Jobs Act of 2018, only losses from federally recognized disasters are eligible as casualty losses.

How will the IRS know if I got an airdrop?

It's best to assume the IRS has full transparency into your crypto activities. Everything on the blockchain is accessible, and the IRS works with centralized exchanges and other third parties to track crypto transactions.

Conclusion

Crypto airdrops can be a great way to accumulate tokens or coins, but it's crucial to understand and comply with the tax implications. Failing to report airdrop income or pay the necessary taxes can result in severe penalties and legal issues.

While the taxation of crypto airdrops varies across countries, many jurisdictions treat them as ordinary income subject to income tax upon receipt. Additionally, any gains or losses from selling airdropped assets are typically subject to capital gains tax.

If you're unsure about reporting requirements or have a complex situation, it's advisable to seek professional help from a qualified tax professional or accountant familiar with cryptocurrency taxation in your country. Staying compliant with tax regulations can save you from potential headaches and ensure you don't miss out on the full benefits of crypto airdrops.

About Arch

Arch is building a next-gen wealth management platform for individuals holding alternative assets. Our flagship product is the crypto-backed loan, which allows you to securely and affordably borrow against your crypto. We also offer access to bank-grade custody, trading and staking services, powered by BitGo.

The information provided here is for educational purposes only and should not be construed as financial or legal advice. Tax laws and regulations can vary, and the tax implications of cryptocurrency transactions may be complex. It is highly recommended that you consult with a qualified tax lawyer and/or accountant to assess your specific situation and ensure compliance with applicable laws and regulations.